Your Wealth Is Entropic: Use It (Or Not), You Will Lose It

Like Life Itself, Your Wealth is Entropic

The hard truth about life is that the moment we are born a process begins that leads to our death. While some days are better than others, our cells and our bodies are on a constant path of growth and decline that leads inevitably to, well, you know where. Physicists refer to this process of gradual decline as “entropy” enshrined in the Second Law of Thermodynamics, which states that there is a natural tendency of any isolated system to degenerate into a more disordered state. Wish as you might, exceptions to this law have never been found.

Because humans are entropic, so too are the things we create, such as wealth. So, it should come as no surprise that every force of nature resists the expansion and perpetuation of wealth, including taxes, spending, inflation, philanthropy, investment loses, theft, divorce, and an expansion in the number of family members. [Editor’s Note: To learn more about family wealth, read “Recognizing Tipping Points to Keep Family Wealth in the Family”.]

Because humans are entropic, so too are the things we create, such as wealth.

The list is a long one and these examples are just the start. There is no way to prevent the entropic dissipation of wealth. If you have a pool of capital (an “isolated system”), that pool will eventually dissipate regardless of the steps you take to slow the tide. The best one can do is to make yet more wealth so that the entropic process can be extended or repeated.

Can We Stop the Loss of Wealth?

Some investors see “wealth preservation” as a middle ground between entropy and new wealth creation. This is a misnomer at best and a myth at worst because as wealth is entropic, it cannot be preserved any more than life can – it can only be cut short or extended a bit. Creating wealth at the same rate at which it dissipates sounds like a way out of this trap but it is not. Wealth dissipation scales perfectly in a linear way, while wealth creation faces diseconomies of scale. It is infinitely easy to dissipate 20% (or more) of every new dollar created, but it is increasingly difficult to grow an expanding pool of wealth by the rate of dissipation.

Grow $1,000 by 20%? Not too hard. Grow $1,000,000 by 20%? Not as easy. Grow $1,000,000,000 by 20%? There is a point at which you simply cannot make money at the same rate as you can dissipate it. This “point of decline” is different for every person but we each have such a point.

In the following illustration, an owner of wealth can outpace dissipation for a time by minimizing spending and taxes, earning income, and generating investment income at or above the rate of inflation. But this is a trick of the eye that makes losing more slowly look like winning. Don’t be fooled: the end is nigh.

More, More, More

But before you rethink your philanthropy, move to a one-bedroom apartment, and revoke your children’s’ trusts, rest assured that all is not lost. You can be sure that, while wealth is entropic, it will grow in an absolute sense (or last over more than one generation) in spite of entropy, by doing two things, neither of which is easy: (1) accept emotionally and intellectually that your wealth is entropic; and (2) make more wealth.

If the dissipation of your wealth is not a concern for whatever reason, the good news is that you don’t have do anything to see that happen. But if you want to outrun entropy, create you must. Here are your primary options:

Earn Money: Earning income is a form of wealth creation, but spending less money is not. Spending less money delays, but does not avoid, the inevitable, not least because there will come a time when you can no longer earn income. Earning helps but it is only a patch on the problem.

Stock Market: Despite its appeal as a long-term investment, public shares and stock indices won’t remedy (and may even exacerbate) the issue. The only historical correlation between stock market returns and inflation is a negative one – stocks go down as inflation goes up. In the context of creating wealth, this presents a double-whammy. At the same time that inflation erodes your buying power (and thus wealth), your stock market investments are likely to be declining, thereby further dissipating your wealth. If you imagine a world without inflation, the market might be your salvation, but you better have a pretty good imagination.

Private Company Investments: Over centuries, the most reliable way to create more wealth is the same way most families created wealth in the first instance: starting and investing in private companies. Starting with the Medici and Rothschild families and continuing to Bezos and Walton and Buffett, the greatest dynastic fortunes have been the product of repeatedly starting or investing in private companies. Apart from their proven ability to create wealth, private company investments have added advantages related to taxation and generational wealth transfer – thereby extending the life of the new wealth they create.

But creating wealth comes at a cost, particularly when one seeks to do so by buying private companies. Among other things, to create wealth in this way means that you typically assume more risk, in particular, the risk of losing money. So, trying to create wealth in this way sometimes leads instead to its own destruction. As a general matter, buying and nurturing private companies consumes more time than most other forms of investing, and time is the most finite and valuable resource yet discovered. These costs associated with risk and time can sometimes be substantial and are almost always unpredictable.

As a general matter, buying and nurturing private companies consumes more time than most other forms of investing, and time is the most finite and valuable resource yet discovered.

This begs the question – what makes us wealthy? Is it just money, or is it some combination of money (acquired with an acceptable amount of risk) and the time to enjoy the fruits of one’s labor? These are personal questions with no right or wrong answers, only answers that are right or wrong for each of us individually. But before you set out to create more wealth, decide whether the better path for you is to accept the inevitable, that wealth is entropic, and, as they say, die just after finishing the last bottle of wine in your cellar.

Over the course of his 25-year career, John has played a leading role in nearly every aspect of private company activity and family office investing. He has structured transactions as a lawyer, improved operations and developed strategy as a management consultant, started companies as an entrepreneur, lead management teams as a CEO and Board Member,…